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One of the most crucial yet widely misinterpreted terms in tax is Reverse Charge VAT. The concept contrasts with the conventional VAT process, making it difficult for people to understand.
Reverse Charge VAT is a shortened mechanism implemented in some countries like the UK and Ireland. In this process, the responsibility of paying VAT shifts from the business owner to the customer. However, this process has specified criteria that must be fulfilled in order to access the reverse charge scheme.
Check out the following article if you want to know what reverse VAT is, who is eligible for it, and when it applies. This guide shall answer all your queries related to the reverse VAT procedures in the UK and Ireland. If you're interested in vat calculation, use our handy VAT Calculator tool todo your vat calculation more accurately.
Conventionally, the supplier charges VAT to the customer (the next ordinate in the supply chain). In most cases, this standard VAT system is used by businesses and companies.
It would be apt to say that VAT is a maze with many categories and types. One of them is reverse VAT. While most schemes relate to the conventional VAT system in one way or another, reverse VAT is entirely the opposite.
In Reverse VAT, the customer does not pay VAT to the supplier. Instead, it directly pays VAT to HMRC. It is a simplified process where the mediator between the customer and HMRC is removed.
The Reverse Charge is designed to prevent swindling and fraud, where many companies charge their customers VAT but do not pass it on to HMRC. Moreover, this system has also created significant ease in the B2B sector, where businesses can operate without worrying about charging VAT at every step.
As a reverse charge VAT example, consider two B2B companies. One company hires a carpenter for business purposes. The carpenter charges £10000 as his service fee. The VAT on this service fee comes out to be £200.
Considering the conventional method, the carpenter would include VAT charges in his fee and collectively charge £1200 from the company. But with this VAT, the situation becomes different.
In this case, the carpenter only charges the company his service fee. And leaves the VAT for the company to pay HMRC on its own. This means that in a reverse charge scenario, the carpenter only invoices for £1000 while the company will directly pay the HMRC £200 VAT.
Since Brexit, the UK has introduced tons of policies that make their reverse charge different from other EU countries. Thus, we shall explicitly dissect the reverse charge policy for the UK under this section.
There are specific eligibility criteria for who can access the reverse-charge VAT scheme. Your business is eligible for this policy if it belongs to one of the following categories;
The following category is ineligible to access the Reverse Charge VAT scheme in the UK.
Domestic Reverse Charge is a specified VAT mechanism only applicable to the UK. It means that the customer purchasing mobile phones and computer chips in the UK must account for VAT instead of the supplier.
Conventionally, when a customer purchases items from your business, you charge them VAT on the invoice and enlist it as VAT Return on your accounts. But you don't charge VAT on your invoice for items subjected to Domestic Reverse Charge . Instead, you only get the amount of the sold items and let the customer pay the VAT to HMRC on their own.
For example, a company purchases computer chips worth £2000 from your business. You will not charge them the £400 VAT on it. Rather, you will make a sales invoice of only £2000. And let your customer pay the £400 tax to HMRC independently.
Before, mobile phone and computer chip suppliers had to compile a Reverse Charge list and submit it to HMRC. But from 1 July 2022, this obligation has been removed. Now, these businesses no longer have to prepare a Reverse Charge list.
HMRC determines where VAT applies and where it does not. Among the eligible sectors comes the ‘Construction Industry Services (CIS)’. According to the new rules, the contractor will report the charge on purchase and sales VAT on the VAT return.
These rules exempt the subcontractor from reporting VAT on the sale invoice. But in the case of a contractor, he will have to record VAT both ways. No matter whether he is purchasing or selling goods, the contractor will record the VAT on his VAT returns.
However, end users and intermediaries are exempted from Reverse Charge. End users are those who perform construction services for their own purposes. In contrast, intermediaries refer to those closely connected to the end-users.
If you fall into any of the two categories, you must contact the sub-contractor and tell them not to reverse the VAT on the sale/purchase invoice. But if you are a sub-contractor receiving such a letter from your contractor, you must clear up the Reverse Charge box from the contractor’s record.
Since Ireland is still a part of the European Union, its rules and procedures for Reverse Charge VAT will differ from the UK. Therefore, if your business territory falls in Ireland, refer to the following Reverse Charge VAT EU procedure.
According to the new criteria set by the Irish government, below are the businesses that must opt for Reverse Charge.
Since Ireland is still part of the European Union (EU), the rules of intra-community acquisition of goods and services will apply to it. But before that, you should be familiar with what intra-community is.
The Intra-community supply and acquisition of goods refers to the transportation or exchange of goods between the EU's Member States (MS). For example, a clothing company sells its goods to people in France and Spain. Then, this kind of supply will be categorized as intra-communal.
Intra-community supply in Ireland is subjected to VAT. Thus, if your business deals with transporting or selling goods to other MS states, you will not charge VAT from the customer in the standard manner.
In lieu of that, you will separate the VAT from the total amount and mention it separately under the VAT returns section. The customer will directly pay VAT to the governing bodies. B2B companies are a better example of how Reverse Charge works for Intra-community supplies.
Like the UK, Reverse Charge also applies to the construction industry in Ireland. The subcontractors are exempted from reporting VAT on VAT returns. Instead, they send purchase and sale VAT invoices to the principal contractor, who then enlists it under his VAT return.
If, as a contractor, your services are eligible for Credit Input, i.e., reclamation of VAT on sales, you should mention it on the form and tick the “Credit Input Reverse Charge VAT” in the Setup section.
Usually, when you make an invoice, you include the VAT in its total amount. But when it comes to Reverse Charge, you cannot do so. You will have to enlist RCT under the VAT Return section, while the remaining amount will be enlisted under the “service fee” section.
Invoicing for Reverse Charge VAT is different from standard VAT. Let’s first discuss the VAT Reverse Charge invoice example from the point of view of a supplier. If you are a supplier, then you don’t need to charge VAT from your customer.
Write off the service/product amount in the invoice but mention the VAT as 0%. Also, add a reference below that no VAT has been charged as of now. The customer will pay the domestic/CIS directly to HMRC.
You can also reference the VAT amount the customer will be accounted for or simply mention the VAT rate. However, it is essential to make the customer aware that it is a reverse charge scenario, and they must report to the governing bodies independently.
Now that you are familiar with the legalities of VAT in the UK and Ireland let's discuss how you can calculate it.
The standard Charge in the UK is 20%. But in Ireland, the VAT is the same as the standard VAT, i.e., 23%. But if your business falls under the reduced category, the VAT reverse charges will be different.
Moreover, it is crucial to remember that VAT does not apply to zero-rated products and services in the UK. But in Ireland, it is applicable, and the zero-rated VAT rate will be followed.
Next, you should determine whether your business activities are eligible for Reverse Charge services. Your supplier will only invoice for the items or services you purchased for them. You can find the reverse charge VAT by dividing the amount of the item/service by 100 and multiplying it by the reverse charge VAT rate.
According to the Domestic Reverse Charge (DRC) policy, the supplier will not charge VAT to the customer upon the sale or completion of services. Instead, the customer directly pays the VAT to HMRC.
In Reverse Charge VAT, the supplier does not charge VAT, and the customer independently pays it to HMRC. Thus, the supplier cannot reclaim VAT in this situation since he didn’t initially charge it. However, the customer can reclaim the VAT on their own from HMRC